Relax Everyone, The High Frequency Trading Problem Is Over

You'll have noticed a number of people worrying over the high frequency trading (HFT) practices in the financial markets in recent years. Michael Lewis even wrote a whole book, Flash Boys, about how nefarious it all was. And there's undoubtedly people campaigning, right now, for markets to be protected from this practice. However, the truth is, just as with pretty much any other form of arbitrage that anyone has ever invented, whatever problems HFT may cause are solved by the markets themselves. And it's possible to point out that, right now, whatever those HFT problems were have indeed now been solved. We rather like the liquidity that it brings to the markets, we most certainly like the lower spreads that exist as a result of it. And HFT itself now seems to be a rather boring activity without any excess profits accruing to those who do it. It's a mature technology if you like, the panic and excitement is over.

And example of people worrying over it all is here, from Mark Buchanan.

So here's one idea for ending the wasteful arms race among high-frequency traders to achieve ever faster execution: Implement a kind of speed limit, perhaps at 0.1 second, and require exchanges to run a batch clearing system. The time interval might even be adjustable, rising and falling with measures of market volatility.

A speed limit on trading would probably be bad news for companies currently profiting from the technology-fueled microsecond scrum over information. But markets are supposed to serve investors and the companies they support, not financial intermediaries.

Buchanan is a physicist who comments upon economics and financial markets. Here is an economics professor who specialises in financial markets talking about them:

Whether it is by the entry of a new destructively creative technology, or the inexorable forces of entry and expansion in a technologically static setting, one expects profits earned by firms in one wave of creative destruction to decline. That’s what we’re seeing in HFT. It was definitely a disruptive technology that reaped substantial profits at the time of its introduction, but those profits are eroding.

That shouldn’t be a surprise. But it no doubt is to many of those who have made apocalyptic predictions about the machines taking over the earth. Or the markets, anyways.

Or, as I say, HFT is really something we just don't have to worry about any more.

This is all as Adam Smith said it would be too. Start from just one premise, that capitalists are greedy. So, when they see someone making "super" profits, profits that are above the general profit level in the economy, then they will start to copy what that other capitalist is doing. Simply because they want to get some of those super profits for themselves. As more capital (and more producers) enter that market then those super profits will be eroded away. We'll end up with the new technology being widespread and all of the producers are back to making normal profits again. This is true of arbitrage opportunities like HFT as it is of something like a smartphone where
Apple is being chased by Samsung and Xiaomi. How difficult the production is to copy will determine how long those super profits last but they will, in the absence of a legally enforced monopoly, have some limited lifetime.

This is the very manner by which capitalism advances in fact. And the end result in HFT is going to be that we'll all enjoy the lower dealing spreads that the extra liquidity brings to the market thanks to all of those robots trading away looking for the super profits that no longer exist. If you prefer to think of it this way, HFT isn't evidence of a problem it's evidence that our basic economic system works as indicated upon the tin. Technological advance makes super profits, capitalists are greedy, so technological advance spreads quickly, super profits disappear and the consumer benefits.